In 2015, Warren Buffett and 3G helped to engineer a merger between two of the twentieth century’s biggest American food brands, Kraft and Heinz. Earlier this year, just four years after the merger, Buffett told his investors that he “misjudged the retail versus brand fight as to who would be gaining ground on the other.”
Stricter food regulations (sugar taxes, salt reduction targets) and shifts in consumer behavior that favor natural foods and budget brands are changing the food industry. At Impax we are particularly interested in the shift to sustainable food — a compelling story that is moving on from its infancy.
There is a notable generational shift in how brands are perceived. Unlike the baby boomer generation, which was largely loyal to brands, millennials have exhibited little loyalty. Poor diets leading to health risks continues to be a global issue, a driver, perhaps, of millennial interest in the quality of the food they buy; they prefer less processed foods and more natural ingredients. This interest has led to greater experimentation with lesser-known brands and supermarkets’ own branded products, a trend that is accelerating. For food companies in this space, the slowdown in the consumption of branded processed foods has had a significant impact.
Less processed, more natural foods are gaining market share from larger branded manufacturers. The natural foods category is growing at a compounded annual growth rate1of nine percent globally, and 27 percent of new product launches today have a natural claim, up from just under 15 percent a decade ago.
Smaller food companies tend to be more nimble than larger manufacturers and more able to respond quickly to changes in the market, commercializing product launches in shorter timeframes — keeping their portfolios relevant. In contrast, companies encumbered by portfolios of long-established brands tend to be slower to launch new products, wary of the risks to their brand image. As a result, smaller brands are outpacing larger food manufacturers, gaining 200 basis points of market share between 2012 and 2015, from 47 percent to 49 percent.2
Faced with these pressures, large brand food manufacturers have responded by investing in both the reformulation of existing products (lower sugar, fat and salt) and new product development. But the desire to attract new customers without disappointing loyal customers has proven a complicated balance for these companies to manage.
Kraft Heinz illustrates this. The company’s value collapsed from its $89 billion initial public offering valuation to $42 billion at the end of March. Dividend payments have been slashed, and it had to endure a $15 billion write-down. Like several of its peers, the company failed to fully appreciate the speed at which consumer appetites were changing, relying on iconic brands over innovation.
To date, the key beneficiaries of the shift in consumer interest have been ingredient companies, whose share prices have risen to new heights thanks to increased demand from food manufacturers, and sustainable packaging (perhaps surprisingly also a part of this narrative). Yet, despite the noise around this topic, the journey is really just beginning.
Since Impax began investing in the sustainable food sector in 2012, we have seen several key moments, but it is fair to say that movement has been at a slow pace. Looking ahead, we see acceleration supported by fast-changing consumer preferences and policy. The new age of sustainable food is coming.
1 Compound annual growth rate is the rate of return that would be required for an investment to grow from its beginning balance to its ending balance, assuming the profits were reinvested at the end of each year of the investment’s lifespan.
2 UBS, “Kerry Group Long-term Growth Undervalued; Assuming Coverage with a Buy,” UBS, Dec. 6, 2017.